4. An analyst has collected data about Devers Co. and a world market index. The

Question

4. An analyst has collected data about Devers Co. and a world market index. The index implies an equity risk premium of 5 percent, and Devers has a beta of 1.2 with respect to the index. When the residuals from the beta regression are collected and included in the regression model as an additional factor, a segmented market risk premium of 13 percent is calculated and the segmented beta with respect to this factor is 0.8. The appropriate risk-free return is 4 percent. If Devers is estimating the cost of common equity for subsidiaries in developed, integrated foreign markets, what is the appropriate cost of common equity?

a.   10.0%

b.   12.1%

c.   16.8%

d.   18.3%

e.   20.4%

Explanation / Answer

Answer: a. 10%

Cost of equity = 0.04 + 1.2 (0.05)

= 0.1 or 10%.

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